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The Eurozone is a fragile financial mammoth. While its GDP lacks the US by around $3 trillion, assets of the banking sector are some 240 percent of GDP vs. around 90 percent in the US. It has been kept standing only through the large-scale asset purchase program (quantitative easing or QE) of the ECB. However, the ECB is about to phase-out its bond buying program, which will affect the debt dynamics and the likelihood of euro survival in a dramatic way.

The tragedy of the Eurozone in three acts

The Eurozone has been built on quicksand. The examples of more than 200 former currency unions suggests rather vividly that a currency union needs to be either backed by a political union or it needs to have an exit option. The eurozone, markedly, has neither.

It was erroneously assumed that when countries join the European Monetary Union (EMU), their economies would start to converge. This means that it was thought that the poorer countries would start to catch-up to the richer ones in well-being and, e.g., productivity. That never materialized. The convergence that was observable during the first years of the euro halted after the financial crisis hit (see the Figure below).

Figure 1. Real (constant) gross domestic product per capita in selected Eurozone countries. Source: GnS Economics, European Commission

After the crisis of 2008, capital started to flee from the weaker member countries of the EZ (see Figure 2 below). When the run on the capital account of Greece, Ireland, Portugal and Spain started to accelerate in 2011, it pushed them on the verge of an default. Their sovereign defaults threatened to bring down major banks, especially in France and Germany. There was also a risk that defaulting countries would be forced to return to their own currency to support their banking system.

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How the Crisis Caused a Pension Train Wreck

September 26, 2018

How the Crisis Caused a Pension Train Wreck

We’ve been writing for some time that one of the consequences of the protracted super-low interest rate regime of the post crisis era was to create a world of hurt for savers, particularly long-term savers like pension funds, life insurers and retirees. Even though the widespread underfunding at public pension plans is in many cases due to government officials choosing to underfund them (New Jersey in the early 1990s is the poster child), in many cases, the bigger perp is the losses they took during the crisis, followed by QE lowering long-term interest rates so much that it deprived investor of low-risk income-producing investments. Pension funds and other long-term investors had only poor choices after the crisis: take a lot of risk and not be adequately rewarded for it (as we have shown to be the case with private equity).

And as we’ve also pointed out, if you think public pension plans are having a rough time, imagine what it is like for ordinary people (actually, most of you don’t have to imagine). It is very hard to put money aside, given rising medical and housing costs. Unemployment means dipping into savings. And that’s before you get to emergencies: medical, a child who gets in legal trouble, a car becoming a lemon prematurely. And even if you are able to be a disciplined saver, you also need to stick to an asset allocation formula. For those who deeply distrust stocks, it’s hard to put 60% in an equity index fund (one wealthy person I know pays a financial planner 50 basis points a year just to put his money into Vanguard funds because he can’t stand to pull the trigger).

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Gold in the “Everything Bubble”: Effective Diversification?

September 25, 2018

Gold in the “Everything Bubble”: Effective Diversification?

What do you do when nearly all asset classes are overvalued?

Diversification is one of the oldest principles by which people try to hang on to their wealth, however little they might have. Don’t put all your eggs in one basket, it goes. Diversification is not designed to maximize profits or minimize costs. It’s designed to get you through a smaller or larger fiasco, not necessarily unscathed but with at least some of your eggs intact so that you can go to market another day. This search for stability is a critical concept when looking at gold as diversification of risk in other asset classes.

There are many reasons to own or trade gold that are beyond the scope of my thoughts here on diversification. So I’ll leave them for another day.

The classic and most basic diversification for American households has been the triad of stocks, bonds, and real estate. In the past, it was often held that when stocks go up, bonds decline. This has to do in part with the Fed, which tends to raise rates when things get hot, thus driving up bond yields (which means by definition that bond prices decline). So stocks and bonds balanced each other out to some extent.

Throw in some leveraged real estate – the house you live in – and in the past, your assets were considered sufficiently diversified.

But this no longer applies today: Stocks, bonds, and real estate – both residential and commercial – all boomed together since the onset of QE in 2009. Other asset classes boomed to, including art and classic cars. Almost everything went up together in near lockstep. For a while, gold and silver, which had been on a surge since 2001 continued to surge. In other words, it was very difficult to achieve actual diversification.

…click on the above link to read the rest of the article…

This ‘Deflationary’ Bull Markets Ending – And Here’s What’s Coming Next For Investors

September 21, 2018

This ‘Deflationary’ Bull Markets Ending – And Here’s What’s Coming Next For Investors

After many years of cheap money and asset bubbles – it looks like the upside is finally over.

That is – the potential upside against the amount of risk taken on – is over.

I often write about investors needing to find asymmetric (low risk – high reward) opportunities. And lately – as I’ve written about earlier this month – many key indicators are now flashing potentially huge downside ahead.

As I wrote then – it’s not like I’m predicting markets to tank tomorrow. Or even next week.

But what I’m getting at is that there’s significantly more risk ahead than reward – at least for the general market and equities.

I’m not alone thinking this way. . .

Bank of America & Merrill Lynch (BAML) recently published a white paper with an interesting trading suggestion. . .

First, they show us that the nearly 10-year monster U.S. bull market has been highlydeflationary. And in case you forgot, deflation refers to when there’s an overall decline in the prices of goods and services.

The ‘deflationary assets’ group includes U.S. investment grade bonds, government bonds, the S&P 500, ‘growth stocks’, U.S. high yield credit, and U.S. consumer discretionary equities (aka non-essential goods – such as luxury goods, entertainment, automobiles, etc.) . . .

And the ‘inflationary assets’ group which includes commodities, developed market stocks (excluding U.S. and Canada), U.S. bank stocks, ‘value stocks’, cash, and treasury inflation protected securities (aka TIPS) . . .

Since the end of the 2008 crash – the Fed embarked on a ‘easy money’ and expansionary path via ZIRP (zero interest rate policy) and QE (quantitative easing; aka money printing).

But even after all this – deflationary assets have seriously outperformed inflationary assets. . .

…click on the above link to read the rest of the article…

Wasting the Lehman Crisis: What Was Not Saved Was the Economy

September 20, 2018

Wasting the Lehman Crisis: What Was Not Saved Was the Economy

Photo Source futureatlas.com | CC BY 2.0

Today’s financial malaise for pension funds, state and local budgets and underemployment is largely a result of the 2008 bailout, not the crash. What was saved was not only the banks – or more to the point, as Sheila Bair pointed out, their bondholders – but the financial overhead that continues to burden today’s economy.

Also saved was the idea that the economy needs to keep the financial sector solvent by an exponential growth of new debt – and, when that does not suffice, by government purchase of stocks and bonds to support the balance sheets of the wealthiest layer of society. The internal contradiction in this policy is that debt deflation has become so overbearing and dysfunctional that it prevents the economy from growing and carrying its debt burden.

Trying to save the financial overgrowth of debt service by borrowing one’s way out of debt, or by monetary Quantitative Easing re-inflating real estate, stock and bond prices, enables the creditor One Percent to gain, not the indebted 99 Percent in the economy at large. Therefore, from the economy’s vantage point, instead of asking how the banks are to be saved “next time,” the question should be, how should we best let them go under – along with their stockholders, bondholders and uninsured depositors whose hubris imagined that their loans (other peoples’ debts) could go on rising without impoverishing society and preventing creditors from collecting in any event – except from government by gaining control over it.

A basic principle should be the starting point of any macro analysis: The volume of interest-bearing debt tends to outstrip the economy’s ability to pay. This tendency is inherent in the “magic of compound interest.” The exponential growth of debt expands by its own purely mathematical momentum, independently of the economy’s ability to pay – and faster than the non-financial economy grows.

…click on the above link to read the rest of the article…

When The U.S. Stock Market Crashes, Buy Gold – David Brady

September 15, 2018

When The U.S. Stock Market Crashes, Buy Gold – David Brady

While we wait for news on the 25% tariffs on $200bln or 40% of Chinese exports to the U.S.—and with the threat of the same on the remaining ~$300bln to follow—I want to outline the endgame for the dollar and the likely beginning of the explosive rally for Gold.

Simply put: When the U.S. stock market crashes, buy Gold.

To be more specific: when the S&P 500 has fallen 20-30%, buy Gold, in my opinion, because the ‘Fed Put’ will soon be exercised at that point. The Fed will reverse policy to stimulus on steroids. The dollar rallied from April 2008 and peaked in March 2009, when stocks bottomed out—the same time the Fed announced QE, or QE1 as we now know it. Then the dollar fell. It is not unreasonable to expect the same to happen this time around. Gold bottomed out in October 2008, as stocks plummeted and then soared 280% to greater than 1900 over the next three years, as QE1 and QE2 were underway.

The coming crash in the U.S. stock market is the catalyst for the Fed’s reversal in policy, so why do I expect a crash?

Quantitative Tightening and Budget Deficits

Lee Adler pointed out several weeks ago that as the budget deficit soars, Treasury bond issuance is increasing by around $100bln per month. At the same time, the Fed is increasing its balance sheet reduction, or “QT” program, to $50bln a month in October, a run-rate of $600bln per year. That means $150bln of additional demand for U.S. Treasuries is required every month.

…click on the above link to read the rest of the article…

Clinging to Old Theories of Inflation

September 15, 2018

Clinging to Old Theories of Inflation

QUESTION: Mr. Armstrong, I think I am starting to understand your view of inflation. It is very complex. I think some people cannot think beyond a simple one dimension concept as you often say. So I am trying to be more dynamic in my thinking process. Here you point out that when debt is collateral it is the same as printing money but worse because it pays interest. Then you point out that hyperinflation takes place not because of printing money but because a collapse in confidence and people then hoard their wealth which reduces the economic output and that compels a government to print more to cover expenses. So there is a line that is crossed and kicks in that collapse in confidence as in Venezuela. This is very interesting but complex. Is this a fair statement?

ANSWER: You are doing very well. You are correct. Some people cannot get beyond an increase in money supply is automatically inflationary one-dimensional thinking. If that was true, then why did 10 years of Quantitative Easing by the ECB fail completely to create inflation given that theory? It is like brainwashing kids with global warming ignoring all evidence to the contrary.

There is yet another dimension that you have to add to this complexity. The BULK of the money is actually created by the banks in leveraged lending. If I lent you $100 and you signed a note that you would repay it, then the note becomes my asset on my balance sheet. I can take that to a bank and borrow on my account receivables. In this instance, just you and I are creating money. Now let a bank stand between us.

…click on the above link to read the rest of the article…

The End Of Cheap Debt: The Fall & Rise Of Interest Rates

September 8, 2018

Creativa Images/Shutterstock

The End Of Cheap Debt: The Fall & Rise Of Interest Rates

Perhaps the greatest single trend impacting the next decade

Total debt (public + private) in America is currently at a staggering $67 trillion.

That number has been rising fast over the past 47 years, following the US dollar’s transformation into a fully-fiat currency in August of 1971.

Perhaps this wouldn’t be such a big concern were America’s income, measured by GDP, growing at a similar rate. But it’s not.

Growth in debt has far outpaced GDP, as evidenced by this chart:

In 1971, the US debt-to-GDP ratio was 1.48x. That’s roughly the same multiple it had averaged over the prior century.

But today? That ratio has spiked to to 3.47x, more than doubling over just 4 decades.

There are many troubling conclusions to draw from this, but here’s a simple way to look at it: It’s taking more and more debt to eke out a unit of GDP growth.

Put in other words: the US economic engine is seizing up, requiring increasingly more effort to function.

At some point — quite possibly some point soon — the economy will no longer be able to grow because all of its output must be used to service the ballooning debt load rather than future investment.

Accelerating this point of reckoning are two major recent trends: rising interest rates and the end of global QE.

Why? Because much of the recent explosion in debt has been fueled by central bank policy:

Interest rates have been on a steady decline since the 1980s, making debt increasingly cheaper to issue and to service.
Since 2008, central banks have been voracious buyers of debt. Countries/companies have been able to borrow $trillions, enabled (both directly and indirectly) by these “buyers of last resort”.

But both of those trends are ending, fast.

…click on the above link to read the rest of the article…

When The US’s Stock Market Bubble Bursts, Inevitable Disaster Will Follow

September 7, 2018

When The US’s Stock Market Bubble Bursts, Inevitable Disaster Will Follow

Complete and utter disaster will be inevitable and unavoidable when the United States’ stock market bubble bursts. Unfortunately, too many think the high stock market is evidence of a stable economy, but it’s actually an artificial bubble that will end in a disastrous crisis.

This unusual market strength is not evidence of a strong, organic economy, but of an extremely unhealthy, artificial bubble economy that will end in a crisis that will be even worse than we experienced in 2008, reported Forbes. The current market is highly unstable due to an artificially low interest rate.

Forbes writer Jesse Colombo explained it well. Ultra-low interest rates help to create bubbles in the following ways:

Investors can borrow cheaply to speculate in assets (ex: cheap mortgages for property speculation and low margin costs for trading stocks)
By making it cheaper to borrow to conduct share buybacks, dividend increases, and mergers & acquisitions
By discouraging the holding of cash in the bank versus speculating in riskier asset markets
By encouraging higher rates of inflation, which helps to support assets like stocks and real estate
By encouraging more borrowing by consumers, businesses, and governments

Another Federal Reserve policy (aside from the ultra-low Fed Funds Rate) that has helped to inflate the U.S. stock market bubble since 2009 is quantitative easing or QE. Many have warned about the negative effects of QE only to be told by leftists that it was “necessary.” When executing QE policy, the Federal Reserve creates new money “out of thin air” in digital form and uses it to buy Treasury bonds or other assets. That action pumps liquidity into the financial system. QE helps to push bond prices higher and bond yields/interest rates lower throughout the economy. QE has another indirect effect as well. It causes stock prices to surge because low rates boost stocks, wrote Colombo.

…click on the above link to read the rest of the article…

The Fed’s QE Unwind Hits $250 Billion

September 7, 2018

The Fed’s QE Unwind Hits $250 Billion

Here’s my math when this “balance sheet normalization” will end.

In August, the Federal Reserve was supposed to shed up to $24 billion in Treasury securities and up to $16 billion in Mortgage Backed Securities (MBS), for a total of $40 billion, according to its QE-unwind plan – or “balance sheet normalization.” The QE unwind, which started in October 2017, is still in ramp-up mode, where the amounts increase each quarter (somewhat symmetrical to the QE declines during the “Taper”). The acceleration to the current pace occurred in July. So how did it go in August?

Treasury Securities

The Fed released its weekly balance sheet Thursday afternoon. Over the period from August 2 through September 5, the balance of Treasury securities declined by $23.7 billion to $2,313 billion, the lowest since March 26, 2014. Since the beginning of the QE-Unwind, the Fed has shed $152 billion in Treasuries:

The step-pattern of the QE unwind in the chart above is a consequence of how the Fed sheds Treasury securities: It doesn’t sell them outright but allows them to “roll off” when they mature; and they only mature mid-month or at the end of the month.

On August 15, $23 billion in Treasuries matured. On August 31, $21 billion matured. In total, $44 billion matured during the month. The Fed replaced about $20 billion of them with new Treasury securities directly via its arrangement with the Treasury Department that cuts out Wall Street – the “primary dealers” with which the Fed normally does business. Those $20 billion in securities were “rolled over.”

But it did not replace about $24 billion of maturing Treasuries. They “rolled off” and became part of the QE unwind.

Mortgage-Backed Securities (MBS)

…click on the above link to read the rest of the article…

Where Will The Next Crisis Come From?

September 1, 2018

Where Will The Next Crisis Come From?

Key Points

It’s been 10 years since a U.S. financial shock turned into a crisis in the global financial, market and economic system.
A shock turns into a crisis when the system is unprepared for it. The system is often at its most vulnerable near the end of the global economic cycle when excesses have built up and managing risks may have been neglected.
The global economic, financial and market system now seems better prepared to manage the shocks of the past were they to repeat in the future. But there are other increased vulnerabilities including: high debt levels, political fragmentation, dependence on international sales, little fiscal or monetary policy ammunition, and the rise of passive investments.

It’s been 10 years since a U.S. financial shock turned into a crisis in the global financial, market and economic system. On September 15, 2008, Lehman Brothers filed for bankruptcy as the shock waves from subprime mortgages rocked the entire financial system, shattering confidence and leading to an economic downfall.

Regularly paying attention to financial news reveals one thing for certain: shocks to the global system happen all the time. Many of these shocks are absorbed by the system without much disruption. Recent examples of shocks might include last year’s escalating geopolitical tensions between the U.S. and North Korea, the U.S. Fed beginning to reverse QE (quantitative easing), or the rapid unwinding of the short-volatility trade that took place earlier this year.

A shock turns into a crisis when the system is unprepared for it. The system is often at its most vulnerable near the end of the global economic cycle when excesses have built up and managing risks may have been neglected. Since we have likely reached the later stages of the cycle, it is now a good time to assess how well the system is prepared for the shocks that lie ahead and where the biggest vulnerabilities may lie.

…click on the above link to read the rest of the article…

Weekly Commentary: Unassailable

September 1, 2018

Weekly Commentary: Unassailable

I’ve been here before and, candidly, it’s not much fun. Lodged in my mind this week was the brilliant quote from the 19th century German philosopher Arthur Schopenhauer: “All truth passes through three stages: First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as self-evident.”

It’s fascinating how it all works. Looking back, there was definitely a Bubble in 1999. Clearly, 2007 was one huge Bubble. Everything is obvious in hindsight, and most look back now and contend it was pretty conspicuous even at the time. Having toiled through both prolonged Bubble periods – arguing against deeply embedded bullish conventional wisdom – I can attest to the fact that the Bubble viewpoint was violently opposed at the late stages of both cycles.

I don’t feel I’m venturing out on a limb to predict that some years into the future the 2018 Bubble backdrop will be recalled as rather self-evident. Years of experimental “whatever it takes” global monetary stimulus (rates, QE and market manipulation) nurtured excess and imbalances on an unparalleled global scale. EM borrowed excessively, too much denominated in foreign (U.S. dollar!) currencies. The Federal Reserve (all central banks) held rates too low for much too long. Prices for virtually all asset classes were inflated to dangerous extremes.

The resulting Tech Bubble 2.0 dwarfed the earlier nineties version, culminating in a global technology arms race. China was a historic Bubble of reckless proportions. Protectionism and Trade wars were a scourge for markets and global growth. Unsound “money” fueled populism. In the end, the backdrop created a cauldron of deepening geopolitical animosities and flashpoints.
…click on the above link to read the rest of the article…

The Anatomy of a Crisis: A Strong Dollar and Disappearing Liquidity

August 19, 2018

The Anatomy of a Crisis: A Strong Dollar and Disappearing Liquidity

Since March – the dollar’s rallied over 7%. And it’s caused the Emerging Markets to implode.

But the bigger problem is what lies ahead.

And that’s a global dollar shortage – which the mainstream continues to ignore. . .

I’ve touched on this a couple months back. Wondering when the mainstream would start to realize that the stronger the dollar gets – the more pressure global economies will feel.

I wrote. . . “This is going to cause an evaporation of dollar liquidity – making the markets extremely fragile. Putting it simply – the soaring U.S. deficit requires an even greater amount dollars from foreigners to fund the U.S. Treasury. But if the Fed is shrinking their balance sheet, that means the bonds they’re selling to banks are sucking dollars out of the economy (the reverse of Quantitative Easing which was injecting dollars into the economy). This is creating a shortage of U.S. dollars – the world’s reserve currency – therefore affecting every global economy.”

Since then, things have only gotten worse. . .

First: Jerome Powell – the Fed Chairman – issued a statement at the end of June that they would actually increase the amount of rate hikes over the next two years. This means they’re tightening even faster.

Second: the U.S. Treasury increased their debt-borrowing needs to the highest since the financial crisis – which was over a decade ago. Therefore, they will need even more dollars to fund their spending.

“The department expects to issue $329 billion in net marketable debt from July through September, the fourth-largest total for that quarter on record and higher than the $273 billion estimated in April [a 17% increase], the Treasury said in a report Monday. The department’s forecast for the October-December quarter is $440 billion, bringing the second-half borrowing estimate to $769 billion, the highest since $1.1 trillion in July-December 2008…”

…click on the above link to read the rest of the article…

Turkey: A harbinger of a global debt crisis?

August 18, 2018

Turkey: A harbinger of a global debt crisis?

The economic crisis brewing in Turkey seems to have surprised many. This was probably, at least partly, due to the ‘period of tranquility’ created by the central banks with theirs ‘unorthodox measures’. Many seem to have imagined that the “synchronized global growth” spurt were here to last. But, it was just a mirage, run by the stimulus of China and the major central banks.

As we warned in May, the global quantitative tightening will bring an end to the current business cycle. This is for a multitude of reasons (see Q-review 1/2018), but the most pressing of them is the fact that QT will raise interest rates and suppress liquidity. It will raise the costs of indebted companies, drive zombie companies to insolvency and ultimately crash the asset markets. A global debt crisis of epic proportions and depression are likely to follow. Turkey is showing what it might look like.

The debt conundrum

The current business cycle has had two exceptional features. First has been the steep rise in the balance sheets of central banks and the second the very fast growth of the non-financial sector debt, especially in the emerging economies. Figure 1 presents the private non-financial sector debt as a percentage of GDP in advanced and emerging economies. It shows the miniscule deleveraging in advanced economies and the harrowing rise in the private non-financial debt in the emerging economies since 2009.

Figure 1. Credit (debt) to non-financial private sector as a share of GDP in advanced and emerging economies. Source: GnS Economics, BIS

The rise of the non-financial private debt in emerging economies coincides with the QE programs of the major central banks.

…click on the above link to read the rest of the article…

Italy Warns that Stopping QE will Lead to Collapse of Eurozone

August 14, 2018

Italy Warns that Stopping QE will Lead to Collapse of Eurozone

Italy has called on the ECB to guarantee the bond yields warning that if they END quantitative easing the Eurozone will break apart. On this score, they are not wrong. The economic spokesman for the Italian governing party Lega has warned of a collapse of the Eurozone. The ECB should ensure that the yield spreads of government bonds of the euro countries are contained and not allowed to soar. This is what Claudio Borghi told Reuters. “Either the ECB offers a guarantee or the euro will break apart.” Interest on Italian, Spanish and Portuguese bonds rose in response to the currency crisis in Turkey. Borghi warned that this situation cannot be solved and will explode in everyone’s face. This is the Sovereign Debt Crisis coming into play. We are no looking at the risk premium for ten-year Italian government bonds has risen to 2.7% above Germany. The promise that a single currency would produce a single interest rate has been a complete failure.

This is what I have been warning about. Ten years of QE has FAILED to stimulate the economy of Europe, it has only made governments addicted to the ECB buying their debt at absurd low levels in rate. The Eurozone will indeed break apart once QE stops for rates will soar and tensions will then rise among the 28 member states for the promise of a single currency would produce a single interest rate pointing to the USA as their proof was a lie. The USA federal debt had a single rate because it was a single authority issuing the debt, not 28 separate states. The better comparison was looking to the 50 states who all experienced different interest rates based on a single currency and their individual CREDIT RATING! The lies of selling the Euro are coming back to haunt them.

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